Fundamental analysis, however, will only get you so far. It does an excellent job of identifying companies that fit my specific requirements and are therefore worthy of accumulating, but it can’t tell me when to buy these little gems. That’s where technical analysis comes in for me. The “when” can only be found by reviewing and researching candidate stock charts. For me, this is how investing works.
For investors that prefer to only use fundamental analysis and ignore technical analysis, their guide for buying into a particular stock is usually based solely on a stock's calculated dividend yield. Since yield is determined by dividing the dividend by the stock price, they know that a constant or improving dividend divided by a falling stock price will create a rising dividend yield. When that yield hits a certain level, it’s time to buy the stock. This is an acceptable method of investing (although pretty basic method) but it does work for some investors. The drawback to this method is that it'll get you into a stock but won't say anything about how or when to get out of a stock. For me, that's simply not enough. I need momentum indicators like moving averages, Bollinger bands, a relative strength index, the MACD, and the ADX. Technical investors have even more indicators at their disposal and can get even more detailed information but these work fine for me.
By reviewing price charts using technical analysis I can determine if a particular stock is overbought, oversold, or acting in that steady and consistent desirable manner. If stocks act appropriately, life is simple. I just monitor my investments and enjoy my ever growing stream of dividends. If stocks are oversold, my decision is easy. The stock is obviously cheap. I simply buy more. But if one of my stocks is overbought, then I have a decision to make. And I have two alternatives. I can either sell the stock and wait for it to fall in price (oversold again), or I can sell covered call options.
"If you have a good selling idea, your secretary can write your ad for you."
- Taxes. If I’ve held a stock so long that claiming the capital gains on my income tax will severely limit my ability of buying the same number of shares after it’s moved into oversold territory, I may decide to sell covered calls instead. Generally the income that I can receive is a fraction of the amount that I can make by simply selling the stock and buying it back at a lower price, but taxes can’t be ignored when making investing decisions.
- The Momentum Investors. Sometimes when a stock has risen faster than warranted by its fundamentals alone it’s because momentum investors have decided to push the stock into new territory. There’s usually some “story” surrounding the stock that’s exciting the crowd to ignore the fundamentals and buy the story. When this happens, call premiums usually increase to the point where they can’t be ignored any longer. It’s time to sell the call and collect the premium. I usually sell short term “just-out-of-the-money” call options to capture the quickly decaying time premium.
- Pending News Item. Just before an impending news announcement call option premiums tend to increase relative to the importance of the announcement. Instead of believing the hype surrounding the story, I like to sell call options on the stock that I own. The amount of in- or out-of-the-money the call is that I sell depends on which way I expect the news to affect the stock price.
- Monthly Income. This is my favorite. I like selling covered call options on all of my stocks on a regular basis for the simple reason of receiving a stream of monthly income. This stream only enhances the yield that I receive from the underlying stock dividends.